How activity in the electricity industry is licensed

There are four main licensable activities in the electricity value chain: generation; transmission; distribution; and supply. It is a surprisingly common misconception that there are still electricity boards or single electricity companies performing all or a combination of these functions. This is largely because one corporate group may participate in all or some of these activities under the same branding.

Licensing

The main functions within the electricity value chain are licensable activities. Unless authorised to do so by a licence or exemption, it is an offence to generate, transmit, distribute, or supply electricity (Section 4, Electricity Act 1989). The offence is triable either way at the institution of the Secretary of State or the Gas and Electricity Markets Authority (GEMA), punishable by a fine up to the statutory maximum if tried summarily and an unlimited fine on indictment.

GEMA was established under Section 1 of the Utilities Act 2000 and acts through the Office of Gas and Electricity Markets (Ofgem). Ofgem currently operates under two brands, with Ofgem E-Serve being the ‘Business Unit’ responsible for environment and sustainability programmes. Licences are granted by GEMA but the process is administered by Ofgem.

Section 6A of the Electricity Act 1989, supplemented by the Electricity (Applications for Licences, Modifications of an Area and Extensions and Restrictions of Licences)

Regulations 2010 (‘Application Regulations’), governs the manner, form, fees, and supporting documentation required to apply for a licence. However, the criteria against which licence applications are assessed are not set out in the Electricity Act 1989 or the Application Regulations. GEMA has discretion as to whether a licence will be granted. The Ofgem documentGas and Electricity Licence Applications— Guidanceillustrates the assessment process and may well establish a legitimate expectation in administrative law as to the criteria GEMA will apply to applications for generation, distribution, and supply licences. However, additional procedural steps apply to transmission licence applications generally (Section 6B, Electricity Act 1989), and potential off shore transmission owners are subject to their own regime under the Electricity (Competitive Tenders for Offshore Transmission Licences) Regulations 2010 and associated guidance, which is not included in the current scope of this work.

Exemptions from the requirement for generation, transmission, distribution, and supply licences may be granted by the Secretary of State pursuant to Section 5 of the Electricity Act 1989. Exemptions may be granted to individuals or to classes of people. A number of individual exemptions have been given from the requirement for generation licences. The class exemption regime is currently governed by the Electricity (Class Exemptions from the Requirement for a Licence) Order 2001. As with its predecessors, this Order has been amended several times, and it would not be surprising if further amendments or a replacement were forthcoming in order to facilitate renewable and embedded generation initiatives driven by the private sector. At present, the (understandably) restrictive licensing regime is inhibiting the development of distributed generation schemes where the generating entity is not consuming all of the power it generates but is, because of the licensing rules, unable to sell the excess as it would like.

Generation

The licensable activity referred to as ‘generation’ in Section 4(1) of the Electricity Act 1989 is the generation of electricity at a relevant place (ie within Great Britain or the adjacent territorial sea or in a Renewable Energy Zone) for the purpose of giving a supply to any premises or enabling a supply to be given. Article 3 of the Electricity (Class Exemptions from the Requirement for a Licence) Order 2001 grants exemptions for the generators falling within Schedule 2 of that Order, which is organized into Classes A to D. Class A is the ‘Small Generator’ exemption.

Class A generators are exempt if they do not provide electrical power from any one generating station in excess of the specified thresholds. For generating stations with a declared net capacity in excess of 100MW, the threshold is 10MW of output. For generating stations with a declared net capacity of less than 100MW, the threshold is 50MW.

‘Declared net capacity’ is determined in accordance with the formulae in Schedule 1 of the Order. Electricity does not count towards these thresholds where it is consumed by a single consumer or a ‘qualifying group’ occupying premises that are on the same site as the generating station, or where some of it is used by that consumer (or qualifying group) and some of it is resold under Class B of Schedule 4 2 in relation to supply licensing exemptions.

‘Qualifying Group’ is defined in Article 2(1) as a group of two or more consumers which are all bodies corporate and which are either connected to each other (provided that any body corporate which is connected to, or a parent undertaking in relation to, any of them is a parent undertaking in relation to all of them) or are each related to each other, were related to each other on 31 March 1990, and were supplied with electricity on 31 March 1990 by the person seeking to fall within the Class in question. Power in excess of the threshold is also disregarded if it is supplied temporarily due to technical circumstances outside the reasonable control of the generator.

Class B applies where the electricity is generated on, and supplied to premises constituting or comprised in, an ‘off shore installation’, which takes its meaning from Regulation 3 of the Offshore Installations and Pipeline Works (Management and Administration) Regulations 1995. Broadly, this exemption covers electricity generated and used on installations such as oil rigs and, save in the off shore environment, is unlikely to be relevant in most circumstances. Likewise, Classes C and D are only relevant to generators that were connected to the ‘total system in England and Wales’ before 30 September 2000. Defined in Article 2(1) as the transmission system in England and Wales of the licensed transmitter and all distribution systems in England and Wales; ‘licensed transmitter’ is defined to include any person holding a transmission licence.

The Class A exemption is therefore the most likely to be relevant in circumstances outside an application for a full generation licence, which means it is most likely to be encountered in relation to small scale renewables projects. The main issue in relation to generation licensing exemptions is therefore the export capacity of the generating station.

Transmission

The National Electricity Transmission System, or ‘NETS’, is the ‘backbone’ of what is sometimes referred to as the national grid. It is a system comprised wholly or mainly of high voltage lines and electrical plant (Section 4(4), Electricity Act 1989). For these purposes, ‘high voltage’ is above 132kV, although it should be noted that the definitions of low voltage and high voltage vary according to which legal instrument is under consideration.

The NETS is actually comprised of several distinct transmission systems, each owned by a different Transmission Owner, who is the holder of a transmission licence. However, the NETS (and its constituent transmission systems) is operated by National Grid Electricity Transmission PLC in its role as NETS System Operator (NETSO). Perhaps confusingly, National Grid also owns one of the transmission systems and is therefore also a Transmission Owner. It is designated as the NETSO by the Secretary of State under the Energy Act 2004 (Designation of System Operator) Order 2004 and has additional ‘NETSO’ licence conditions incorporated into its transmission licence, unlike the other Transmission Owners.

The NETSO has a number of functions but for present purposes these can be reduced to two: ‘balancing’ the NETS and providing a single interface between users of the NETS and the three Transmission Owners.

Distribution

The Ofgem website draws a distinction between distribution network operators (DNOs) and independent distribution network operators (IDNOs) and states that IDNOs are ‘independent network operators who own and run smaller networks embedded in the DNO networks’. In this context, ‘independent’ means new entrant network operators since liberalization, which were never in state ownership (whereas DNOs were formerly state-owned businesses). However, from a legal perspective the differences are relatively few.

Both DNOs and IDNOs are usually companies limited by shares. The Application Regulations clearly contemplate that this is not mandatory, as the definition of ‘shares’ draws a distinction between applicants with share capital and without. DNOs hold licences treated as granted under Section 6(1)(c) of the Electricity Act 1989; IDNO licences are granted under the same provision. DNO and IDNO licences also share the same Standard Licence Conditions.

The main legal differences are the means by which the licenses are granted (or treated as granted), being by way of fresh applications (IDNOs) or transfer schemes under Section 108 and Schedule 7 of the Utilities Act 2000 (DNOs), and the additional licence conditions to which DNOs are subject as a result of their historic size and geographical scope.

New distribution licence applications (which, in accordance with the definitions above, are for IDNO licences) are made under the Electricity (Applications for Licences, Modifications of an Area and Extensions and Restrictions of Licences) Regulations 2010. Alternatively, a person proposing to develop a distribution system may apply for an individual licence exemption. At the time of writing no individual exemptions had been granted from the requirement for a distribution licence. However, Schedule 3 of the Electricity (Class Exemptions from the

Requirement for a Licence) Order 2001 contains a number of class exemptions for distribution network operators.

Class A (Small Distributors) allows a person to distribute up to 2.5MW of electrical power at any one time for the purpose of supplying, or enabling electricity to be supplied, to domestic consumers. If the distributor is a body corporate (as is likely to be the case), then electricity distributed by an associated, connected, or related body corporate counts towards the 2.5MW to the extent that the additional power does not fall within Class B. Article 2 of the Regulations provides for what is an ‘associated’, ‘connected’, or ‘related’ body corporate. However, it does so by reference to provisions that have been repealed (under the Companies Act 1985 and the Income and Corporation Taxes Act 1988). The equivalent definitions in the Companies Act 2006 and the Corporation Tax Act 2010, and the transitional rules in relation to those Acts, appear to fill the apparent gap in the Regulations.

Class B (On-Site Generation) allows a person to distribute up to 1MW of electrical power at any one time for the purpose of supplying, or enabling electricity to be supplied, to domestic consumers, provided that the electricity was generated by a generating station embedded in the same distribution system as the receiving consumer. This requirement is not conceptually straightforward in circumstances where the exempt distribution system is connected to other networks.

Electricity is distributed on a displacement basis, much like water—the laws of physics dictate that when electricity enters the system at one point there is a corresponding displacement of electricity at another point on the system. To say that the consumer must be receiving electricity from any one particular generating station is, in practice, impossible if electricity can get onto the distribution system from other sources—eg if a stand-by supply is taken from another source, as is clearly contemplated in paragraph 2 of Class B. This states that ‘stand-by electrical power’ does not count towards the 1MW threshold. ‘Stand-by electrical power’ is power supplied periodically or intermittently to make up any shortfall in a self-generated supply, where the generating station is ‘wholly or partly’ out of commission. This suggests that an exempt distributor under Class B may be distributing power from both the embedded generator and an alternative source simultaneously.

The question as to whether the consumer is receiving its power from embedded generation is therefore likely to be decided by the contractual position (ie is there a power purchase arrangement between the relevant generator and consumer?).

Class C (Distribution to Non-Domestic Consumers) appears simple on its face. It exempts distributors who do not distribute electricity for the purpose of supplying, or enabling that electricity to be supplied, to domestic consumers. A ‘domestic consumer’ is a consumer supplied with electricity at domestic premises, but only to the extent that they are supplied with electricity at domestic premises—ie if they also receive a supply at non-domestic premises then, to that extent, they are also a non-domestic consumer. ‘Domestic premises’ are premises at which a supply is taken wholly or mainly for domestic purposes (Article 1).

Class D (Off shore Distributors) exempts distributors who only distribute electricity generated by off shore generating stations. This exemption, added in 2007, deals with ‘array cables’ connecting off shore wind turbines to the off shore substation that marks the point of connection with the off shore transmission system, and it is unlikely to be relevant outside that context.

Supply

New supply licence applications are also made under the Electricity (Applications for Licences, Modifications of an Area and Extensions and Restrictions of Licences) Regulations 2010. Alternatively, a person proposing to supply electricity may seek an individual exemption. At the time of writing, no individual exemptions had been granted from the requirement for a supply licence. However, Schedule 4 of the Electricity (Class Exemptions from the Requirement for a Licence) Order 2001 contains a number of class exemptions for suppliers, which are examined below.

It will immediately be seen that, as with the other exemptions, the supply licence exemptions are particularly narrow. This has the potential to impede the development of innovative embedded generation solutions where, for example, an embedded, self-supplying generator has consumed all of the electricity it requires on-site, but has a surplus that it would like to use at another of its sites or to sell directly to a third party that is not a licensed supplier.

The substantive point here is that the prohibited activity of ‘supplying’ includes the supply of electricity to premises where it is conveyed to those premises wholly or partly by means of a distribution system (Section 4(4), Electricity Act 1989). ‘Distribution system’ is defined within the definition of ‘distribute’ in Section 4(4) of the Electricity Act 1989.

A distribution system is a system which consists wholly or mainly of low voltage lines and electrical plant and is used for conveying electricity to any premises or to any other distribution system—the Act does not distinguish between licensed and licence-exempt distribution systems. Therefore, a person proposing to supply electricity which is conveyed through a distribution system must (in order for the supply to be lawful) obtain a supply licence or be entitled to (or obtain) an exemption. This can prevent a generator from making the most efficient use of its power in both the technical and economic senses, as the cost of complying with a supply licence once obtained can be prohibitive, not least because of the personnel, IT, and other systems required to comply with industry code obligations, as well as needing to meet liabilities such as climate change levy and the renewables obligation.

In the related guidance (contained in the same document in draft form, but confirmed as the final form in the Ofgem document Gas and Electricity Licence Applications— Guidance), GEMA states that such a derogation will only be granted if robust alternative arrangements for code compliance are in place. This is necessary because the industry agreements—for example the Balancing and Settlement Code and the Master Registration Agreement—are central to the mechanisms by which the physical volumes of electricity in the system are balanced. If the new licensee is permitted to introduce power to the system, there must be a way for that power to be captured in these mechanisms. In practice, that means ‘subcontracting’ these obligations to a third party electricity supplier that is party to the relevant codes and is participating in the balancing mechanism. To the author’s knowledge, no derogations from SLC 11 have been granted.

Schedule 4 of the Electricity (Class Exemptions from the Requirement for a Licence) Order 2001 sets out the supply licensing exemptions; Class A (Small Suppliers) allows a person to supply up to 5MW of electricity which is generated by the person itself, provided that no more than 2.5MW of this is supplied to domestic customers. ‘Domestic customer’ has the same meaning as in relation to the distribution exemptions. Where the exempt person is a body corporate, any electricity supplied by another, associated body corporate counts towards the exemption threshold—to prevent circumvention of the regime through the creation of a fleet of ‘small suppliers’.

Class B allows people to resell electricity that has been sold to them by a licensed supplier or by an on-site supplier that is exempt under Class C of the same schedule. The conditions on resale of electricity purchased from a licensed supplier appear, at first sight, to be minimal. However, the precise wording of the exemption is that the person may resell electricity ‘which is supplied to their premises’. On its natural meaning, this suggests that the electricity must have been actually conveyed to the premises from which it is to be resold. The Resale of Gas and Electricity, Guidance for Resellers (Ofgem, 2005) suggests that this is the intention; the majority of examples it gives are, essentially, scenarios where tenants are purchasing resold electricity from landlords.

Class C allows people to supply electricity that they have generated themselves, either exclusively or in combination with electricity that has been supplied to them by a licensed supplier; however, such electricity may only be supplied to consumers of the seven limited classes specified in Class C. Although Class C is broadly described as the ‘on-site supply’ exemption, the different scenarios in which the exemption is available are highly fact-sensitive and should be examined in detail when considering whether they apply or whether a supply licence will be required.

This is an excerpt from 'Procurement of Utilities Law and Practice' by Pinsent Masons energy expert Matthew Collinson, published by Oxford University Press.

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